In 2008, my MBA classmates and I investigated Jim Cramer’s recommendations and found the following:

Buying Cramer’s picks after he recommended them underperformed the broader stock market. There seems to be a “bump” relative to the market for his picks that has happened faster than you could conceivably trade.

Cramer’s mid cap and large cap picks did not outperform the market, and “shorting the bump” would be an interesting strategy for high-frequency traders.

Cramer’s small and micro cap picks do a little better than small cap indexes after he discusses them.

Cramer might be trying to do the impossible by making daily stock picks. He provides entertainment, relays business news, interviews executives, and displays an impressive, encyclopedic knowledge of publicly-traded companies. He is like Stone Phillips, Oprah, and Bloomberg News combined. However, these talents did not translate into alpha for his mid and large cap picks.

Exploiting any persistence of these effects is fairly simple. Contrarians should review large and mid cap stocks recommended by Cramer and consider whether there is merit to taking the opposite positions. From this week’s large and mid cap picks, KMP, CLB, CRM, MSFT, and RIMM are challenged.

What could an investor expect from these three picks? We can model total returns over a three year holding period for each of these stocks. (I use a 3-year holding period since above-average growth estimates are not reliable further out.) Giving Cramer the benefit of the doubt for buy recommendations, the stock is assumed to be sold at a generous growth stock price to earnings multiple of 17 and the maximum of historical and analyst estimate values for earnings growth are assumed.

On the contrary, we will use more conservative values to give Cramer the benefit of the doubt for his sell recommendations. For his sell calls, a bargain value stock price to earnings multiple of 10 and the minimum of historical and analyst estimates values for earnings growth are assumed. These assumptions are used to project an annualized total return over the next three years and a terminal price to earnings ratios, that is, price paid today divided by earnings at the end of the holding period for each stock:

Even with assumptions that would favor Cramer’s sell recommendations for Microsoft (NASDAQ:MSFT) and Research In Motion Limited (RIMM), these sell recommendations cannot be supported given current valuations. Even terrible scenarios look good for these stocks: holding these stocks through three years with the lesser of historical growth or analyst growth estimates and then selling at a bargain 10 price-to-earnings multiple would reap 14% and 59% annualized returns, respectively.

In addition, Cramer’s buy recommendations for Kinder Morgan Energy Partners LP (NYSE:KMP), Core Laboratories NV (NYSE:CLB), and Salesforce.com (NYSE:CRM) are not supported even by a rosy scenario. Buyers of these stocks who enjoy the greater of historical growth and analyst growth estimates and are able to sell at a growth stock P/E ratio would still suffer negative total returns. Regardless of conceivable growth levels, the price is just too high for these stocks. Intrepid contrarians should research KMP, CLB and CRM as a sell picks, rather than trusting Cramer’s buy recommendation on each stock.

Bear in mind that challenging the consensus requires a strong will. In addition to countering Cramer, contrarians have to shut out the allure of stories and other distractions in order to focus on valuation.

Disclaimer: This article was written to provide investor information and education, and should not be construed as a guarantee or investment advice. I have no idea what your individual risk, time-horizon, and tax circumstances are: please seek the personal advice of a financial planner. This article uses third-party data and may contain approximations and errors. Please check estimates and data for yourself before investing. Moreover, this research does NOT constitute a guarantee.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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